How Should You Calculate Customer Lifetime Value?

sloanreview.mit.edu – Should marketers subtract the cost of acquiring a customer before assessing that customer’s lifetime value?

Customer lifetime value (CLV), which is the present value of cash flows from a customer relationship, can help managers make decisions regarding investments in customer relationships.1 For example, a marketer might use CLV to decide whether to spend marketing dollars to acquire new customers or to increase the retention rate of existing customers. CLV can be difficult to calculate because it often relies on the ability to predict future customer retention rates.2 However, we think one major source of confusion among marketers — whether to include customer acquisition cost in the CLV calculation — can be easily avoided. CLV is easier to understand, and in our view more useful, if marketers don’t subtract the acquisition cost from their calculation of CLV before reporting it.3 To be sure, customer acquisition costs are a major item in marketing budgets. Such costs should affect decisions as to whether to pursue prospective customers. But this does not mean that acquisition costs need to be subtracted from CLV before the value of the customer is reported.